GOP omits ‘derivatives’ from crisis report

RonaldD. Orol

WASHINGTON (MarketWatch) — Republicans omitted the words “derivatives” and “deregulation” from their report released Wednesday on the cause of the financial crisis that shook the economy to the brink in 2008.

Instead, the report, released by GOP members of a bipartisan Financial Crisis Inquiry Commission, concentrates much of its 13 pages on how mortgage refinance giants Fannie Mae and Freddie Mac, as public companies, contributed to the crisis by investing in and guaranteeing mortgages of “increasingly lower quality and higher risk to the taxpayer.” It also argues that mortgage-related losses at big banks that were undercapitalized all led to a financial panic. Read the report

The four-person Republican group, which includes former House Ways and Means Committee Chairman Bill Thomas, broke from the Democratic members, who are expected to release their report on the crisis in late January. The statute setting up the FCIC requires the panel to submit its report by today.

The GOP report argues that Fannie and Freddie attracted private investors and increased their risky mortgage investments, in part, because shareholders understood the companies retained an implicit government guarantee. The two companies also were encouraged by both the Clinton and Bush administrations to meet affordable housing goals, which also contributed to their riskier investments, it said.

The Republicans argued that the unprecedented number of subprime and other weak mortgages” created a mortgage bubble and bust that set this crisis apart from other housing bubbles in the past.

“During the inflation of the housing bubble, [Fannie and Freddie] lowered their standards and began investing in subprime and Alt-A mortgages—and to great fanfare, as the national homeownership rate averaged 68.7% from 2003 to 2006,” the report states.

“The government, in effect, encouraged the GSEs to run two enormous monoline hedge funds that invested exclusively in mortgages and were implicitly backed by the U.S. taxpayer,” the report said.

The report also takes credit rating agencies to task, arguing they contributed to the crisis.

“The credit rating agencies made many of the same mistakes as mortgage investors, and their ratings on MBS proved to be severely inflated—an important reason that these credit and liquidity risks were not appreciated by financial firms,” the report said. McGraw-Hill’s
MHP, +0.00%
Standard & Poor’s, Moody’s
MCO, +0.57%
and Fimalac-held (FIM) Fitch Ratings are the main credit-rating agencies.

Democrats call report ‘revisionist whitewash’

Democrats quickly lashed out at the report, criticizing it for failing to focus on deregulation and derivatives. Tom McMahon, Executive Director, Americans United for Change, argued that Republicans are “just trying to protect their bank buddies.”

“It was Wall Street that made bad bets with our money in the shadow banking system, which led to the lost of 8 million jobs and billions in retirement savings,” McMahon said in a statement.

Democratic members of the FCIC are likely to focus some of their much anticipated report on a lack of regulation for one type of over-the-counter derivatives, credit-default swaps, arguing it had a role in the financial crisis.

A major purveyor of these swaps, American International Group Inc.
AIG, +0.27%
, required a government injection of $180 billion to keep it afloat to prevent the crisis from widening. In one hearing, Democrats explored the relationship between Goldman Sachs
GS, +2.08%
and American International Group Inc., questioning Goldman’s valuation of its contracts with the insurance giant during the height of the crisis and whether the valuation helped drive the crisis and added to questions about AIG’s future.

As expected, top Republicans backed the report.

“This eye-opening report details how government mortgage companies played a pivotal role in the financial meltdown by handing out high-risk loans to families who couldn’t afford them,” said incoming House Speaker John Boehner, an Ohio Republican. “After years of being coddled and enabled by Washington politicians, Fannie Mae and Freddie Mac are now on life support, kept afloat by taxpayers fed up with unending bailouts.”

“Our top priority in the next Congress is winding down the government sponsored enterprises [Fannie and Freddie] that were at the heart of the crisis and received the largest bailout of them all. It’s time for the Administration to join us in making GSE reform a priority,” Bachus said.

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